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# Tutorial 2 questions ECON203 Microeconomic Analysis (Session 2, 2018) Tutorial 2 N.B This is economics – diagrams are always your friend J 1. Consider the following budget and preference...

Tutorial 2 questions
ECON203 Microeconomic Analysis (Session 2, 2018)
Tutorial 2
N.B This is economics – diagrams are always your friend J
1. Consider the following budget and preference representation for an agent:
The agent has an income of 300, the price of good 1 is 4 and the price of good 2 is 10.
(a) How much of good 1 does this agent consume?
(b) If the price of good 1 falls to \$2.50, while income and the price of good 2 stay
constant, how much of good 1 will the agent consume?
(c) How much income must be taken away from this agent to isolate the Hicksian
income and substitution effects?
(d) The total price effect of the price change is to change consumption from the point
[ ] to the point [ ]? (fill in the blanks with the co
(e) The income effect co
esponds to the movement from the point [ ] to the point
[ ] while the substitution effect co
esponds to the movement from the point [ ] to
the point [ ].
(f) Is good 1 a normal good or an inferior good?
2. In completely legitimate and totally non-stalkerish ways, you have been able
to compile the following information about a sequence of choices by an agent
named Martin:
a) Show Martin’s budget constraints for each of the 3 weeks, and indicative
indifference curves.
) What can you deduce about Martin’s preferences? Why?
c) Indicate the income and substitution effects of the price change for good 1.
Explain any surprising results.
3. Feng has this utility function over consumption and leisure: ! = #\$%. His
friend Ha-eun has this utility function: ! = #%\$. The price of the consumption
good is 1, and the hourly wage for working is 4. Neither Feng nor Ha-eun have
any non-labour income.
Find Feng’s and Ha-eun’s weekly income.
[Hints: a week has 7 days of 24 hours each; every hour of leisure means 1 hour not
worked; given the price of consumption, income and total consumption have the
same value.]

Untitled
ECON204 MACROECONOMIC ANALYSIS
SESSION 2, 2018
WEEK 3
TUTORIAL QUESTIONS

For the homework questions, please keep the following in mind:
- Each question is based on your country
egion
- When asked to draw a graph, please use statistics (either monthly, quarterly or yearly, whichever is
available) for the last 30 years (less than this only if no statistics are available)
- When asked to draw a graph, Excel would be an appropriate software program. Hand-drawing in
unnecessary, you could just

For homework on your group’s country
- Find the data and then draw a graph of nominal and real GDP over time.
- Draw a graph of the growth rates of nominal and real GDP over time.
- Find the data and then draw a graph of inflation over time. Specify the type of inflation being used.

Question 1

Suppose that the economy is characterized by the following behavioral equations:
C = XXXXXXXXXXYD
I = 500+0.25Y
G = 900
T = XXXXXXXXXX2Y
Solve for
a. Compute total demand at equili
ium.

. Assume that G is now equal to 1200. Solve for equili
ium output. Compute total demand. Is it
equal to production? Explain.

c. Assume that G is equal to 1200, so output is given by your answer to (b). Compute private plus
public saving. Is it equal to investment? Is it higher or lower than when G was 900? Explain.

d. What is the multiplier? What happens to the multiplier if tax revenue (T) is instead fixed at 3000?
Explain.

Question 2
Suppose that wealth is \$5trn and can be in money and bonds only. Suppose that yearly income is
\$1.5trn. Also, suppose that money demand function is given by
Md = \$Y (.8 - 2i)
a. What is the demand for money and the demand for bonds when the interest rate is 2% (i=0.02)?
4% (i=0.04)?
. Describe the effect of the interest rate on money demand and bond demand. Explain.

c. In percentage terms, what happens to the demand for money if yearly income is reduced by
10%?

Now suppose that the supply of money is \$1trn. Assume equili
ium in financial markets.
d. Calculate the equili
ium interest rate.

e. If the Reserve Bank of Australia wants to decrease i to 0% at what level should it set the supply of
money? How does it do that?

3. Consider an economy with a banking sector. Money demand is given by
Md = \$Y(0.35- i) where \$Y is \$2trn. Suppose that people desire to hold 20% of their money in cu
ency
(c=0.2) and 80% in deposits. Also, suppose that banks hold 10% of all deposits as reserves (θ=0.1).

a. Given that the central bank desires to keep the interest rate at 3% (i=0.03), what should be the
supply of central bank money? What will be the overall money supply?

. Show and calculate the money multiplier. Explain its meaning.

c. During the Great Depression in the 1930s, bank runs led to people taking their money out of
anks, prefe
ing to keep it in cu
ency. How did this shift from deposits to cash affect the size of
the money multiplier?
Answered Same Day Aug 09, 2020 ECON204

## Solution

Shivagya answered on Aug 12 2020
ECON204 MACROECONOMIC ANALYSIS
Solution 1)
C = 1000 + 0.75 YD
I = 500+0.25Y
G = 900
T = 100 + 0.2Y
(a) AD = C + I + G + NX            (Consumption, Investment, Govt. Spending & Net Exports)
Also at equili
ium, YD = Y – TA + TR
YD = Y – (100 + 0.2Y) + 0
YD = 0.8Y – 100
Applying this in the expanded Demand equation,
AD = (1000 + 0.75YD) + (500 + 0.25Y) + 900 + 0
= 2400 + 0.75YD + 0.25Y
= 2400 + 0.75(0.8Y – 100) + 0.25Y
= 2325 + 0.85Y
At equili
ium, the total demand equals the output, hence
Y = 2325 + 0.85Y
0.15Y = 2325
(b) G = 1200
Therefore, AD = (1000 + 0.75YD) + (500 + 0.25Y) + 1200 + 0
At Equili
AD = Y = 2625 + 0.85Y => 0.15Y = 2625
(c) Y = C + S + TA - TR            (Income is either consumed or saved or paid in taxes)
Y = C + I + G + NX
C + S + TA – TR = C + I + G + NX
I = S + (TA – TR – G) – NX         (Investments is equal to public saving + private saving)
Public Saving = TA – TR – G – NX = 100 + 0.2Y – 1200 = 0.2Y – 1100
Private Saving = S
500 + 0.25Y = S + 0.2Y – 1100
0.05Y = S – 1600, or S = 0.05Y + 1600
S = (0.05 * 17,500) + 1600 = 2475
Public Saving = 0.2Y – 1100 = 2400
I = 500 + 0.2Y = 500 + (0.2 * 17,500) = 4000    (Net savings are more than investment)
When G = 900,
Public Savings = = TA – TR – G – NX = 100 + 0.2Y – 900 = 0.2Y – 800 = (0.2*15,500) – 800 = 2300
I = S + (TA – TR – G) – NX => 500 + 0.25Y = S + 2300
S = 0.25Y – 1800 = 2075
I = 4375            (Investment is higher when government curtails expenditure)
(d) The multiplier is the amount by which equili
ium output changes when autonomous aggregate demand increases by 1 unit.
AD = C + I + G + NX
C Ĉ c.YD C c(Y TR TA)             (Consumption as a function of disposable income)
C = Ĉ + c(Y + TR – t.Y)                (Tax Rate ‘t’)
C = Ĉ + c.TR + c(1-t)Y
AD = [Ĉ + c.TR + c(1-t)Y] + I + G + NX         (Assuming Ĉ, TR, I, G & NX to be constant)
AD = Ĉ + c(Y + TR – T) + I + G + NX
AD = Ā + c(Y – T)                (Where T = TA = Tax Revenue)
Or c = (AD – Ā)/(Y - T)
At equili
c = (Y – Ā)/(Y – T)
When tax revenue T = 0.2Y + 100, c = (Y – Ā)/ (0.8Y – 100)
When tax revenue is fixed at 3000, c = (Y – Ā)/ (Y – 3000)
We can see that when the Tax Revenues are fixed at 3000 the multiplier reduces in value.
Solution...
SOLUTION.PDF